SMALL BUSINESS 

ADMINISTRATION

Review of 7(a) 

Guaranteed Loans to 

Select Franchisees

Report to Congressional Requesters

September 2013

GAO-13-759

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-13-759, a report to 

congressional requesters

September 2013

SMALL BUSINESS ADMINISTRATION

Review of 7(a) Guaranteed Loans to Select 

Franchisees

Why GAO Did This Study

From fiscal years 2003 to 2012, SBA 

guaranteed franchise loans under its 

7(a) program totaling around $10.6 

billion. SBA made guarantee payments 

on approximately 28 percent of these 

franchise loans, representing about 

$1.5 billion, according to SBA. GAO 

was asked to examine SBAguaranteed loans to franchisees, and 

to investigate an allegation that a loan 

agent provided exaggerated revenue 

projections to franchisees of the same 

franchise organization to help them 

qualify for SBA loans. 

This report describes (1) the 

magnitude of SBA-guaranteed loans to 

franchisees of the franchise 

organization, and (2) the results of 

GAO’s investigation into the allegation, 

and aspects of SBA’s oversight of its 

7(a) loan program with respect to loans 

made to franchisees of the franchise 

organization. 

GAO examined SBA’s loan data and 

files of loans made to franchisees. 

GAO used the franchise organization’s 

revenue data to compare to revenue 

projections in SBA applications, as well 

as revenue reported in the 

organization’s disclosure documents. 

As part of the investigative work, GAO 

interviewed the franchisor, loan agents, 

and select borrowers to better 

understand the franchising experience. 

GAO is not making any 

recommendations. In their comments, 

representatives of the franchise 

organization state that GAO’s 

comparison of average revenue in the 

disclosure document and the first-year 

average revenue calculation is 

potentially misleading and inaccurate. 

GAO disagrees, as discussed in more 

detail in this report.

What GAO Found

Analysis of guaranteed loans to franchisees of a select franchise organization 

reviewed by GAO, approved from January 1, 2000, to December 31, 2011, 

showed the Small Business Administration (SBA) approved a total of about $38.4 

million for 170 loans made by 54 lenders. SBA’s guaranteed portion on these 

loans was approximately $28.8 million. Of the total population of 170 loans, 74 

loans defaulted, 55 of which (74 percent) originated from four lenders that had 

the highest loan volume and default rates on loans to the franchisees. SBA made 

guarantee payments of around $11 million on the defaulted loans to franchisees,

including about $8.5 million in guarantee payments on the 55 defaulted loans 

from these four lenders. Of the 88 loans reviewed from the four lenders, 55 (63 

percent) defaulted. In comparison, 19 of the 82 loans (23 percent) that originated 

at the other 50 lenders to the franchisees defaulted. As part of GAO’s 

investigative work, GAO interviewed the owners of 22 franchisees of the 

franchise organization in GAO’s review, of which 16 defaulted on their loans and 

10 filed for bankruptcy protection. Interviewed franchisees noted difficulties 

meeting anticipated revenue estimates and limited access to information that 

would aid in business planning. 

GAO was unable to conclusively determine whether the loan agent referred to 

GAO for investigation intentionally provided exaggerated revenue projections to 

franchisees to help them qualify for SBA loans, and SBA has taken initial steps to 

enhance program oversight. The loan agent stated that she obtained the revenue 

projections from her employer and former clients, one of which she identified. 

She then provided these revenue projections to clients. The employer and former 

client she identified denied providing the revenue projections to the loan agent. 

SBA’s Office of Credit Risk Management debarred the loan agent and her 

employer for encouraging false statements, among other things, making them 

ineligible to work with the federal government for a period of 3 years beginning in 

January 2012. According to GAO’s analysis, the first-year projected revenues on 

loan applications involving the loan agent or her employer were, on average, 

more than twice the amount of actual first-year revenue for 19 of the 24 

franchisees reviewed. Potential franchisees should include first-year revenue 

estimates in their SBA loan applications. However, this information is not 

necessarily available to potential franchisees in the franchise organization’s 

disclosure document, which provides information about the organization’s 

financial performance representations and franchisees’ estimated initial 

investment, among other things. Further, federal regulations do not require 

franchise organizations to provide actual first-year average revenues for start-up 

businesses in their disclosure document. Thus, potential franchisees may have to 

conduct due diligence to identify this information from other sources, if available. 

GAO also identified discrepancies and other issues in SBA’s franchise loan data 

with respect to fields used for risk-based oversight of its loans portfolio, such as 

default status, number of loans, and loan agent information. SBA has taken, or is 

considering steps, to address these issues and enhance oversight of loan 

agents. For instance, SBA is working with a third-party vendor to replace SBA’s 

current franchise codes with publicly available identifiers used in the franchise 

industry. At the time of GAO’s review, it was too early in the process to assess 

the effectiveness of these actions.

View GAO-13-759. For more information, 

contact Stephen M. Lord at (202) 512-6722 or 

lords@gao.gov or Wayne A. McElrath at (202) 

512-6722 or mcelrathw@gao.gov.
Page i GAO-13-759 Small Business Administration

Letter 1

Background 5

Defaulted Loans to Franchisees of the Franchise Organization 

Resulted in $11 Million in Guarantee Payments, and Four 

Lenders Accounted for about 74 Percent of Defaulted Loans 8

Alleged Loan Agent Fraud Could Not Be Conclusively Determined, 

and SBA Has Taken Initial Steps to Enhance Oversight of Loan 

Agents and Improve Loan Data Quality 12

Agency and Third-Party Comments and Our Evaluation 20

Appendix I Objectives, Scope, and Methodology 23

Appendix II Summary of Risk-Based Reviews of Four Lenders 27

Appendix III Financial Disclosure Document (FDD) Analysis and 

Franchising Due Diligence 29

Appendix IV Comments from Representatives of the Franchise 

Organization 31

Appendix V GAO Contacts and Staff Acknowledgments 35

Tables

Table 1: Summary of Discrepancies Found in the Small Business 

Administration’s (SBA) Franchise Loan Data 18

Table 2: Summary of Small Business Administration’s (SBA) RiskBased Reviews of Four Lenders 27

Contents
Page ii GAO-13-759 Small Business Administration

Figures

Figure 1: Small Business Administration (SBA) Paid $11 Million in 

Guarantee Payments for Loans from Franchisees of the 

Franchise Organization (Approved from Jan. 1, 2000, to 

Dec. 31, 2011) 9

Figure 2: Two Lenders Accounted for over Half of All Defaulted 

Loans to Franchisees from the Four Lenders Approved 

from January 1, 2000, to December 31, 2011 10

Abbreviations

BCP Bureau of Consumer Protection

FDD Financial Disclosure Document

FTA fiscal and transfer agent

LAS Loan Accounting System

NMLS Nationwide Mortgage Licensing System and Registry

OIG Office of Inspector General

PACER Public Access to Court Electronic Records

PLP Preferred Lenders Program

SBA Small Business Administration

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Page 1 GAO-13-759 Small Business Administration

441 G St. N.W.

Washington, DC 20548

September 10, 2013

The Honorable Mary L. Landrieu

Chairwoman

Committee on Small Business and Entrepreneurship

United States Senate

The Honorable Tom Coburn, M.D.

Ranking Member

Committee on Homeland Security 

 and Governmental Affairs

United States Senate

The Honorable Carl Levin

Chairman

Permanent Subcommittee on Investigations

Committee on Homeland Security 

 and Governmental Affairs

United States Senate

From fiscal years 2003 to 2012, the Small Business Administration (SBA) 

guaranteed 32,323 franchise loans under its 7(a) program—a lending 

program intended to assist small-business borrowers, including 

franchisees—totaling around $10.6 billion. SBA made payments to honor 

its guaranty on approximately 28 percent of these franchise loans, 

representing about $1.5 billion, according to SBA.1 The 7(a) program is 

the primary lending program of SBA and guarantees as much as 75 or 85 

percent of an outstanding commercial loan balance, depending on the 

size of the loan.2

 1

According to SBA officials, this figure does not include loan recoveries, and, therefore, 

losses may be less. In addition, officials said the figure reflected loans that lenders selfidentified as SBA-guaranteed franchise loans. Thus, the officials noted the number may 

not reflect all franchise loans guaranteed by SBA. 

Proceeds from 7(a) loans may be used to establish a 

2

SBA’s 7(a) loan program is authorized under Section 7(a) of the Small Business Act (15 

U.S.C. § 636(a)), which authorized SBA to provide business loans and loan guarantees to 

U.S. small businesses. SBA can guarantee as much as 85 percent of loans up to 

$150,000 and 75 percent of loans of more than $150,000. In addition, SBA also offers 

SBA Express loans up to $350,000 with a maximum guarantee of 50 percent. The SBA 

Express program allows lenders to use, to the extent possible, their respective loan 

analyses, procedures, and documentation. SBA Express loans can be used as a revolving 

line of credit, as well as a term loan.
Page 2 GAO-13-759 Small Business Administration

new business or to assist in the operation, acquisition, or expansion of an 

existing business, among other uses. The 7(a) program involves SBA, 

commercial lenders, borrowers, and in some cases, loan preparers or 

other agents, who are private entities that offer SBA loan application 

services for a fee. Default on an SBA loan may result in taxpayer loss, as 

well as potential personal hardship for the borrower, such as financial 

distress or bankruptcy. As part of its oversight efforts, SBA generally 

conducts reviews of all 7(a) lenders with SBA-guaranteed loan portfolios 

of $10 million or more on a 12- to 24-month cycle. SBA can conduct 

additional reviews of the lenders if it identifies specific performance 

concerns.

We have previously reported on SBA’s oversight of the 7(a) program, in 

particular SBA’s assessments of lenders’ practices for determining 

whether borrowers were unable to obtain credit at reasonable terms in the 

conventional lending market and the agency’s use of the lender risk-rating 

system for oversight and predicting lender performance.3

You asked that we examine SBA-guaranteed loans to franchisees, and to 

investigate an allegation that a loan agent provided exaggerated revenue 

projections to franchisees of the same franchise organization to help them 

qualify for SBA loans. This report describes (1) the magnitude of SBAguaranteed loans to franchisees of the franchise organization, and (2) the 

results of our investigation into the allegation, and aspects of SBA’s 

oversight of its 7(a) loan program with respect to loans made to 

franchisees of the franchise organization. Any mention of franchisees 

throughout this report refers to borrowers obtaining SBA-guaranteed 

We reported 

that SBA’s 7(a) program had some program weaknesses, such as limited 

guidance on how lenders should document that borrowers could not 

obtain credit elsewhere. We made several recommendations, including 

one that SBA issue more detailed guidance to lenders on how to 

document their compliance with the credit elsewhere requirement. SBA 

generally agreed and has taken some action in response, such as 

revising its guidance to lenders on how to document their determination 

that borrowers could not obtain credit elsewhere.

 3

GAO, Small Business Administration: Actions Needed to Improve the Usefulness of the 

Agency’s Lender Risk Rating System, GAO-10-53 (Washington, D.C.: Nov. 6, 2009) and 

Small Business Administration: Additional Guidance on Documenting Credit Elsewhere 

Decisions Could Improve 7(a) Program Oversight, GAO-09-228 (Washington, D.C.: Feb. 

12, 2009).
Page 3 GAO-13-759 Small Business Administration

loans to open or acquire one specific franchise. Reference to the 

franchise organization refers to the overall franchise and its management.

To conduct our audit work, we examined data for all SBA-guaranteed 

loans to franchisees of the select franchise organization approved from 

January 1, 2000, to December 31, 2011, in order to assess loan volume, 

default rates, and the amount of SBA’s guarantee payments made for 170 

loans to franchisees from 54 lenders. We selected this date range in 

order to obtain a broad understanding of SBA-guaranteed loans to 

franchisees during different economic conditions and from multiple 

lenders. The original dataset we received from SBA included 184 loans to 

franchisees; however, 16 of these indicated that the lender canceled the 

guarantee on the loan and 2 were outside the scope of our review.

4 We 

therefore excluded these loans from our analysis. From these data, we 

selected four lenders with the highest loan volume and default rates. 

Three of these four lenders are preferred lenders, which mean they have

delegated authority to make lending decisions on behalf of SBA.5

 4

We identified two SBA-guaranteed loans that fell outside the scope of our review, 

including one loan approved for a different franchise organization and another loan that 

was not originated by one of the four lenders. The number of loans we received in the 

original dataset that were relevant to our review, excluding these two loans and the 16 

canceled loans, was 166 loans. However, during our review of the loans from the four 

lenders to the franchise organization, we identified four loans that were not in the dataset 

we received from SBA. Thus, in all, we reviewed 170 loans from the four lenders to the 

franchise organization. 

We also 

reviewed 88 SBA loan packages for these four lenders in order to 

examine characteristics of individual loans, such as the extent to which 

the franchisees’ projected first-year revenues differed from actual firstyear revenues, as well as to assess the accuracy of certain data fields in 

the SBA franchise loan data. These loan packages included all loan 

packages for these lenders during this time period. We assessed the 

reliability of the SBA loan data by comparing it to information in loan files 

for the four lenders and interviewing knowledgeable agency officials. We 

found discrepancies between data in SBA’s loan database and 

information in the loan files we reviewed, as discussed later in this report, 

but we determined that the SBA loan data were sufficiently reliable for 

reviewing loans to franchisees.

5

Prior to March 2011, the four lenders had delegated authority.
Page 4 GAO-13-759 Small Business Administration

We analyzed revenue data that we obtained from the franchise 

organization to calculate actual first-year revenue of franchisees, when 

possible. We compared these calculations with the projected revenues in 

SBA loan applications for select franchisees. We also calculated average 

revenues for a broader population of franchisees, and compared it to 

average revenues reported in the franchise organization’s disclosure 

documents. We identified several issues with the accuracy and 

completeness of the franchise organization’s revenue data, including 

missing, duplicate, and nonsequential revenue data. For purposes of data 

reliability, we excluded these businesses from our calculations. However, 

after assessing the reliability of the revenue data, we determined that they 

were sufficiently reliable for purposes of our analysis.

We also interviewed SBA officials about their activities related to 

oversight of the four lenders to the franchise organization, efforts to track 

and monitor loan agents, and assistance provided to potential franchisees 

during the loan application process. In addition, we examined SBA’s 

policies and procedures for overseeing lenders in the 7(a) program. We 

also reviewed reports by SBA’s Office of Inspector General (OIG) and 

other related documents.6

To conduct our investigative work, we reviewed an allegation that a loan 

agent intentionally exaggerated first-year revenue projections on SBA 

loan applications in order to ensure that potential franchisees would 

qualify for SBA-guaranteed loans. We interviewed the owner of the 

franchise organization, the loan agent who was the subject of the 

allegation, her employer, eight former franchisees that were referred to us 

during the course of the investigation, and a bank officer who reviewed 

loans related to the allegation. To better understand the franchisees’ 

experience with the 7(a) program, we interviewed 14 additional 

franchisees of the select franchise organization. We selected these 

franchisees on the basis of a range of factors, including whether they 

used a loan agent, geographic dispersion, and performance status of the 

 6

Small Business Administration, Office of Inspector General, The SBA’s Portfolio Risk 

Management Program Can Be Strengthened, Report No. 13-17 (July 2, 2013); Report on 

the Most Serious Management and Performance Challenges Facing the Small Business 

Administration in Fiscal Year 2013, Report No. 13-02 (Oct. 15, 2012); Addressing 

Performance Problems of High-Risk Lenders Remains a Challenge for the Small Business 

Administration, Report No. 12-20R (Sept. 28, 2012); Report No.11-16 (July 13, 2011); and 

Material Deficiencies Identified in Early-Defaulted and Early-Problem Recovery Act Loans,

Report No. ROM 10-19 (Sept. 24, 2010).
Page 5 GAO-13-759 Small Business Administration

loan. The 14 franchisees received 19 SBA-guaranteed loans from one of 

the four lenders included in our review. In addition, on the basis of the 88 

loan packages we reviewed for the four lenders, we identified 24 

franchisees that used the loan agent connected to the allegation or her 

employer, 19 of whom had data available to compare the first-year 

revenue projections on SBA loan applications with the franchisees’ actual 

first-year revenue. We are unable to generalize our findings from these 

interviews and analysis to other franchisees, loan agents, franchise 

organizations, or borrowers in the 7(a) program. Our intent was not to 

identify potential fraud or abuse for all franchise loans of the franchise 

organization, or the 7(a) loan program as a whole.

We conducted this performance audit from March 2012 to September 

2013, in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence that provides a reasonable basis 

for our findings and conclusions based on our audit objectives. We 

believe that the evidence obtained provides a reasonable basis for our 

findings and conclusions based on our audit objectives. We conducted 

our related investigative work in accordance with the standards 

prescribed by the Council of the Inspectors General on Integrity and 

Efficiency. For a more detailed description of our scope and methodology, 

see appendix I.

SBA’s 7(a) loan program is intended to help businesses obtain credit that 

they are unable to secure in the conventional lending market. Under the 

7(a) program, SBA guarantees loans made by commercial lenders. 

Borrowers may use 7(a) loan proceeds to establish a new business, 

expand an existing business, or purchase an existing one, including a 

franchised business. Loan proceeds can be used to buy equipment, 

finance working capital, purchase or renovate a building, and pay for 

other expenses. Currently, the maximum loan amount for a 7(a) loan is $5 

million. The average 7(a) loan for fiscal year 2012 was $337,730. Loan 

maturities vary based on the borrower’s ability to repay and the intended 

use of loan proceeds.7

 7

The maximum loan maturity for real estate and equipment is 25 years, and loans for 

capital and inventory can have a maturity of up to 10 years. 

Background
Page 6 GAO-13-759 Small Business Administration

To qualify for a 7(a) loan, the applicant must be deemed creditworthy, 

have demonstrated an inability to obtain credit elsewhere on reasonable 

terms from nonfederal sources, and be able to reasonably ensure 

repayment. Lenders are required to consider these factors for each 

applicant. In addition, lenders are required to report any fees paid to loan 

agents, and other agents who assist the borrower during the loan 

origination process, using the “Fee Disclosure Form and Compensation 

Agreement” (Form 159).8

SBA’s Preferred Lenders Program (PLP) is part of SBA’s effort to provide 

streamlined financial assistance to the small-business community, 

including franchisees. Under this program, SBA delegates the final credit 

decision, as well as most servicing and liquidation authority and 

responsibility, to a group of preferred lenders. SBA relies on these 

lenders to ensure that borrowers meet the program’s eligibility 

requirements. SBA considers potential preferred lenders on the basis of 

their performance records with SBA, and they must have demonstrated a 

proficiency in processing and servicing SBA-guaranteed loans. In fiscal 

year 2011, SBA had 3,537 active lenders in the 7(a) program, 545 of 

which had preferred lender status.

In general, examples of loan agents include: (1) 

loan packagers, who are agents compensated by loan applicants or 

lenders to prepare loan applications; (2) referral agents, who refer loan 

applicants to lenders or vice versa, and may be compensated by either 

party; and (3) lender service providers, who carry out lender functions in 

originating, disbursing, servicing, or liquidating SBA loans in return for 

compensation from lenders.

SBA’s Office of Credit Risk Management conducts on-site reviews of 

certain lenders through a risk-based review process. On-site reviews are 

generally to be conducted on all 7(a) lenders with outstanding balances of 

$10 million or more on the SBA-guaranteed portions of their loan 

portfolios. SBA’s risk-based review process is to consider factors such as 

portfolio performance, SBA management and operations, credit 

administration practices for both performing and nonperforming loans, 

and compliance with SBA requirements. According to SBA’s procedures 

for conducting on-site risk-based lender reviews, SBA can assess a 

lender as (1) acceptable, which means the lender is managing a 

 8

Lender service providers identify and disclose their fees in a Lender Service Provider 

Agreement, which they submit to SBA for review.
Page 7 GAO-13-759 Small Business Administration

satisfactory SBA loan program using prudent lending practices and 

representing limited financial risk to SBA; (2) acceptable with corrective 

actions required, indicating the lender may have weaknesses, but it is 

reasonably expected that the lender can address the issues during the 

normal course of operations; (3) marginally acceptable with corrective 

actions required, meaning the lender demonstrates serious deficiencies 

and demonstrates an inadequate degree of understanding and 

management of the SBA loan program; and (4) less than acceptable with 

corrective actions required, which means the lender is operating an SBA 

loan program with serious deficiencies or represents significant financial 

risk to SBA.

When a borrower with an SBA-guaranteed loan defaults, the lender has 

the option of submitting a purchase request to SBA to honor the 

guaranteed portion of the loan. Effective November 15, 2010, SBA 

defined an early defaulted loan as one in which the borrower defaulted 

within 18 months of initial disbursement.9

A franchise is a business model that involves one business owner (the 

franchise organization) licensing trademarks and methods to another (the 

franchisee). The franchisee pays the franchise organization a fee. As an 

aid to potential franchisees considering opening or purchasing a 

franchise, franchise organizations are required by law to provide certain 

information about their franchise organization in their Financial Disclosure 

Document (FDD).

Prior to that date, early 

defaulted loans were those that defaulted within 18 months of final

disbursement. Early defaulted loans may indicate potential deficiencies in 

the originating, closing, and servicing of loans. According to SBA’s 

procedures, the agency must review guaranty purchase requests for early 

defaulted loans with a higher degree of scrutiny than other defaulted 

loans.

10

 9

In addition, according to the Standard Operating Procedures 50-51-3, when the final 

disbursement occurs more than 6 months after the initial disbursement, the 18-month 

period commences from the date of final disbursement. Loan disbursements can be made 

over time as long as all loan proceeds are disbursed within 24 months after the date of the 

loan approval. 

The disclosure document provides information about 

the organization, such as financial performance representations, the initial 

franchise fees, franchisees’ estimated initial investment, and the 

franchisor’s litigation history, among other information. The financial 

1016 C.F.R. § 436.2. This regulation was issued by the Federal Trade Commission. 
Page 8 GAO-13-759 Small Business Administration

performance representations in the FDD, which can include average 

revenue figures and other earnings statements, are optional and can vary 

by franchise organization. Current regulations stipulate that the financial 

performance representation must have a reasonable basis and 

substantiation at the time it was made.11 Potential borrowers have the 

option to request additional information from the franchise organization 

regarding the financial representations made in the FDD. In addition, 

franchise organizations may provide the names and contact information 

of current and former franchisees in the FDD.

Our analysis of SBA-guaranteed loans to franchisees of the franchise 

organization approved from January 1, 2000, to December 31, 2011,

showed that SBA approved a total of about $38.4 million for 170 loans 

made by 54 lenders. SBA’s guaranteed portion on these loans amounted 

to around $28.8 million. Of the total population of 170 loans, we identified 

74 defaulted loans, 55 of which (74 percent) were originated by four 

lenders. Three of these four lenders are preferred lenders that have 

delegated authority to make lending decisions on behalf of SBA.12 SBA 

made guarantee payments of around $11 million on the defaulted loans, 

including about $8.5 million in guarantee payments on the 55 defaulted 

loans from these four lenders.13 Figure 1 illustrates the dollar value of 

SBA guarantee payments for loans from the four lenders. In addition, 

figure 1 shows that loans originating with Lender A and Lender B 

comprised about 64 percent of the $11 million in guarantee payments 

disbursed by SBA for loans to the franchisees of the franchise 

organization.14

 1116 C.F.R. § 436.5.

12Prior to March 2011, the four lenders had delegated authority.

13We identified 55 defaulted loans for the four lenders to franchisees; however, SBA made 

guarantee payments for 53 of these defaulted loans. The average approved dollar amount 

of 7(a) loans from these four preferred lenders to franchisees, excluding SBA Express 

loans, was approximately $326,000. We excluded SBA Express loans from this calculation 

because the approved loan amount for the 22 of the 23 loans of this type for the four 

lenders was no more than $30,000, and often these loan proceeds were not disbursed.

14All dollar figures are presented in nominal dollars and have not been adjusted for 

inflation.

Defaulted Loans to 

Franchisees of the 

Franchise 

Organization Resulted 

in $11 Million in 

Guarantee Payments,

and Four Lenders 

Accounted for about 

74 Percent of 

Defaulted Loans
Page 9 GAO-13-759 Small Business Administration

Figure 1: Small Business Administration (SBA) Paid $11 Million in Guarantee Payments for Loans from Franchisees of the 

Franchise Organization (Approved from Jan. 1, 2000, to Dec. 31, 2011)

Notes: Data are from SBA’s loan data and loan files for the four lenders. a

We identified 55 defaulted loans for the four lenders to franchisees from SBA data and loan files 

provided by SBA; however, SBA made guarantee payments for 53 of these defaulted loans. 
Page 10 GAO-13-759 Small Business Administration

Of the 88 loans we reviewed from the four lenders, 55 (about 63 percent) 

defaulted.15

Figure 2: Two Lenders Accounted for over Half of All Defaulted Loans to 

Franchisees from the Four Lenders Approved from January 1, 2000, to December 

31, 2011

In comparison, 19 of the 82 loans (23 percent) that originated 

at the other 50 lenders to the franchisees defaulted. As shown in figure 2, 

two lenders—Lender A and Lender B—represented about 82 percent of 

the defaulted SBA-guaranteed loans to franchisees from the four lenders 

(45 of the 55 defaulted loans), and over half of the total defaulted SBAguaranteed loans to franchisees from all the lenders (45 of the 74 

defaulted loans).

Note: Data are from SBA’s loan data and loan files for the four lenders.

 15We identified 63 franchisees who received at least one loan from one of the four 

lenders. Overall, at least 31 of the 63 franchisees filed for bankruptcy. Some of these 

franchisees received more than 1 of the 88 SBA-guaranteed loans we reviewed from the 

four lenders. In addition, some franchisees received loans that were approved and 

defaulted during the financial crises from 2007 to 2009.
Page 11 GAO-13-759 Small Business Administration

SBA oversees preferred lenders, in part, through its risk-based review 

process. SBA conducted such reviews on these four lenders, and found 

in 16 of 17 reviews conducted that the lenders’ management of their SBA 

loan programs was either acceptable or acceptable with corrective 

actions required. One of the five reviews for one lender, Lender A, 

determined the lender’s management was marginally acceptable with 

corrective actions required, including improvements to the lender’s 

policies, procedures, and controls for demonstrating certain underwriting 

decisions.16 In September 2012, SBA OIG issued a report noting that 

during SBA’s onsite reviews, the agency did not always recognize the 

significance of lender weaknesses for 8 of the 16 sampled lenders and it 

did not require lenders to correct performance problems that could have 

exposed SBA to unacceptable levels of financial risks.17

In addition, as part of our investigative work, we interviewed the owners of 

22 franchisees of the franchise organization to obtain background 

information on the SBA loan process and efforts to start their 

businesses.

SBA OIG made 

six recommendations in the report, including proposals that SBA develop 

and implement a process for assessing lender weaknesses in terms of 

their risk to the agency, and that SBA tailor the scope of on-site reviews 

of lenders to identify and address the weaknesses underlying lender 

ratings. SBA agreed with the recommendations and the report noted it 

has taken steps to address concerns in the lender oversight process. For 

additional details on SBA’s risk-based review of the four lenders, see 

appendix II.

18

 16The period SBA conducted the risk-based reviews varied by lender, as described in 

more detail in app. II.

One franchisee we interviewed obtained an SBAguaranteed loan that defaulted within 9 months of final disbursement, 

making it an early defaulted loan. The franchisee highlighted challenges 

related to insufficient working capital and unexpected expenses. The 

17Small Business Administration, Office of Inspector General, Addressing Performance 

Problems of High-Risk Lenders Remains a Challenge for the Small Business 

Administration, Report No. 12-20R (Sept. 28, 2012).

18We selected 14 franchisees who received 19 SBA-guaranteed loans to provide 

anecdotal information about the process of obtaining an SBA loan. As part of our review of 

the allegation, we interviewed 8 additional franchisees for a total of 22 franchisees. For 

additional details on our selection process, see app. I. 
Page 12 GAO-13-759 Small Business Administration

franchisee ultimately filed for bankruptcy in March 2010.19 In addition, 

franchisees we interviewed noted difficulties meeting anticipated revenue 

estimates, as well as limited access to information that would aid in 

business planning. While some of the franchisees we interviewed who 

had not defaulted on their loan expressed similar challenges faced by 

those with defaulted loans, one of the franchisees with a nondefaulted 

loan told us he maintained excess capital in order to withstand slow 

periods, and he highlighted previous business experience. The 

experiences described in our interviews with the 22 franchisees are not 

generalizable to the broader population of franchisees, other franchise 

organizations, or 7(a) borrowers in general, but they provide additional 

background and highlight some of the difficulties experienced by these 

franchisees.20

We were unable to conclusively determine whether the loan agent 

referred to us for investigation intentionally provided exaggerated revenue 

projections to franchisees to help them qualify for SBA loans; however, 

we found that first-year projected revenues on loan applications involving 

the agent or her employer were, on average, more than twice the amount 

of actual revenue for 19 of the 24 franchisees we reviewed in the first 

year of operations. Our review of the allegation included obtaining 

information on SBA’s efforts to track and monitor loan agent involvement

during the loan origination process. SBA has taken some steps to 

enhance oversight of loan agents and to improve the completeness and 

accuracy of data in its franchise loan portfolio.

As part of our investigative work, we examined an allegation that a 

specific loan agent provided exaggerated revenue projections to some 

franchisees of the franchise organization in our review to assist them in 

qualifying for SBA-guaranteed loans. Potential franchisees and lenders 

 19Of the 22 franchisees we interviewed, 16 defaulted on their loans and 10 filed for 

bankruptcy protection.

20The difficulties some of these franchisees faced may have been attributable to the 

economic downturn, given that the default dates for 12 of the 16 loans occurred from 2008 

through 2010. 

Alleged Loan Agent 

Fraud Could Not Be 

Conclusively 

Determined, and SBA 

Has Taken Initial 

Steps to Enhance 

Oversight of Loan 

Agents and Improve 

Loan Data Quality

Results of Investigation of 

Alleged Fraud Were 

Inconclusive
Page 13 GAO-13-759 Small Business Administration

may choose to employ loan agents to assist in the preparation of SBA 

loan applications. In an interview in February 2012, the loan agent told us 

she obtained the revenue projections from her employer and former 

clients, one of which she identified. The loan agent told us she provided 

these revenue projections to clients. The employer and former client she 

identified denied providing the revenue projections to the loan agent. 

SBA’s Office of Credit Risk Management debarred both the loan agent 

and her employer, and they are ineligible to work with the federal 

government for a period of 3 years beginning in January 2012. SBA 

debarred the loan agent on the basis of evidence supporting other 

grounds, including charging impermissible contingency fees, encouraging 

7(a) loan applicants to violate SBA requirements by inflating working 

capital requests, and directing prospective borrowers not to disclose fees. 

In addition, the loan agent’s employer was debarred for impermissible 

contingency fees and encouraging false statements in connection with the 

7(a) program. On the basis of interviews with the loan agent, her 

employer, eight former franchisees, and a bank officer for the loans, and 

our associated audit work we could not conclusively determine whether 

the loan agent intentionally provided misleading first-year revenue 

projections to SBA loan applicants of the franchise organization.

To better understand the role of loan agents and the preparation of SBA 

loan applications, we interviewed three loan agents who were not the 

subject of the allegation we received. These three loan agents stated that 

they did not provide clients with revenue projections, and one of them 

said it would be improper to do so. The Federal Trade Commission’s 

Bureau of Consumer Protection (BCP) Buying a Franchise: A Consumer 

Guide encourages franchisees to conduct due diligence on any earning 

representations, including potential earning claims that the loan agent or 

other individuals may provide.

During our review of the 88 loans files, we identified 6 loan agents, 

including the subject of the allegation, who assisted franchisees in 

preparing SBA loan applications. For SBA loans involving these loan 

agents, to the extent possible, we assessed the accuracy of franchisees’ 

first-year revenue projections on their SBA loan applications by 

comparing those figures to their actual first-year revenues using the 

franchise organization’s revenue data. First-year revenue projections on 

SBA applications that involved the loan agent we reviewed as part of our 

investigation were, on average, higher than the franchisees’ actual firstyear revenue. The magnitude of this difference was also higher than what 

we found for other loan agents; however, the number of loans involving 

Projected and Actual 

Revenue Differed, and 

Franchisees Should 

Exercise Due Diligence in 

Obtaining Accurate FirstYear Revenue Projections
Page 14 GAO-13-759 Small Business Administration

loan agents with available data to make this calculation was limited and 

the results are not statistically significant or generalizable to other SBA 

loan applications.

Of the 88 SBA-guaranteed loans from the four lenders, we identified 24 

franchisees with loans that indicated the loan agent referred to in the 

allegation, or her employer, assisted the franchisee in preparing the SBA 

loan application.21 Revenue projections from the loan application and 

actual revenue data from the franchise organization were available for 19 

of these 24 franchisees, all of whom were owners of start-up franchises. 

On average, for these 19 franchisees, first-year revenue projections on 

their SBA loan applications were 2.7 times the actual revenues the 

franchisees made in their first year of operations.22

In the 88 loan files we reviewed for the four lenders, we found 10 loans 

that involved a specific loan agent other than the one who was the subject 

of the allegation. We found first-year revenue projections in the loan files 

for 5 of these 10 loans.

The first-year revenue 

projections for these 19 loans ranged from 1.02 times to 8.6 times the 

actual revenues the franchisee made in the first year of operations.

23

In addition, federal regulations require franchise organizations to provide 

potential franchisees with certain information in their FDD—the disclosure 

document intended to aid individuals who are considering opening or 

For these 5 loans, we compared the first-year 

revenue projections from the loan files to the actual revenue of the 

business during the first year of operations. The revenue projections for 

the five loans were, on average, 1.5 times the actual revenues the 

franchisees made in their first year of operations. The first-year revenue 

projections on the SBA applications for these five loans ranged from 1.03 

times to 2.8 times the franchisees’ actual first-year revenues.

 21The loans we identified involving the loan agent and her employer were disbursed prior 

to their debarment. Overall, among the four lenders with the most defaults and loans to 

the franchise organization, we identified 40 loans made to 24 franchisees that involved the 

loan agent or her employer. We also identified 5 loan agents who assisted with 10 loans. 

For the remaining 38 loans we received for the four lenders, we did not find evidence in 

the loan files that indicated the involvement of any loan agent. 

22For the 19 loans involving the loan agent, we found that all but 3 of the franchisees had 

first-year revenue projections that were at least 1.44 times actual first-year revenues. 

23The 5 loans involved three different loan agents.
Page 15 GAO-13-759 Small Business Administration

purchasing a franchise.24 While the franchise organization can choose to 

include earnings statements in the FDD, federal regulations do not 

require franchise organizations to provide actual first-year average 

revenues for start-up businesses in the disclosure document.25

Several franchisees told us that they use FDDs when developing revenue 

estimates, but we found that the reported average revenue in the 

franchise organization’s FDD tended to be higher than our calculated firstyear average revenues. We reviewed the FDDs of the select franchise 

organization in order to determine the average revenue it reported to 

potential franchisees. The franchise organization’s average revenue in its 

FDD accounted for all franchisees in operation the full calendar year 

before issuance of the FDD, not just first-year average revenue.

Franchisees should include first-year revenue estimates in an SBA loan 

application; however, this information is not necessarily available to 

potential franchisees in the FDD and they may have to conduct due 

diligence to identify this information from other sources, if available. For 

example, some franchisees we interviewed said they relied solely on 

information provided by the loan agent for developing revenue estimates. 

Other franchisees we spoke to highlighted different sources of financial 

information about the franchise organization, including existing or 

previous franchisees and the franchise organization’s FDD when 

developing revenue estimates.

26 We 

used the franchise organization’s revenue data to calculate, to the extent 

possible, first-year average revenues for only its start-up businesses.27

 2416 C.F.R. § 436.2. This regulation was issued by the Federal Trade Commission and it 

stipulates that the financial performance representation must have a reasonable basis and 

substantiation at the time it was made.

We then compared our first-year average revenue calculation to the 

average revenue figures reported in the franchise organization’s FDD 

over a 10-year period. For 9 of the 10 years we reviewed, the average 

revenue in the franchise organization’s FDD was higher than our average 

2516 C.F.R. § 436.5.

26Apart from assessing the franchisees accounted for in the franchise organization’s 

average revenue calculations, we did not assess the methodology for the revenue 

calculation in the franchise organization’s FDDs.

27Our first-year average revenue calculation excluded 63 businesses the franchise 

organization told us were not start-up businesses. In addition, we excluded businesses 

that had potential reliability issues, including, but not limited to businesses that did not 

report 12 consecutive months of revenue or reported duplicate months of revenue. 
Page 16 GAO-13-759 Small Business Administration

revenue calculations, after we excluded from our calculation all 

businesses the franchise organization told us were not start-up 

franchises. In addition, for the 10-year period the average revenue in the 

franchise organization’s FDD had a median value that was 1.43 times our 

average revenue calculation. In addition, we calculated the average 

revenue figure for the franchise organization, including the 63 businesses 

the franchise organization told us were not start-up businesses. The 

result of this calculation did not differ substantially from the franchise 

organization’s average revenues in the FDDs. See appendix III for 

additional details about our analysis.

SBA’s website offers some information about the challenges of 

franchising, and it directs potential franchisees to the website of the 

Federal Trade Commission’s BCP for additional guidance. Likewise, the 

BCP’s Buying a Franchise: A Consumer Guide warns potential 

franchisees about unauthorized or misleading earning representations, 

highlighting the importance of franchisees conducting due diligence when 

applying for a franchise loan. According to SBA officials, SBA has limited 

interaction with franchisees because it delegates the application process 

to the preferred lenders. However, officials said individuals can visit one 

of SBA’s district offices, which provide resources for starting a business. 

Further, SBA has programs that are intended to help businesses start and 

grow by providing training, counseling, and access to resources, such as 

Small Business Development Centers, which provide services through 

professional business advisors. We identified other resources available to 

potential franchisees. For instance, a third party currently submits 

Freedom of Information Act requests for SBA franchise loan data, which it 

then uses to conduct franchise performance analysis. The analysis, which 

includes default rates and charge-off rates listed by franchise 

organization, is available to the public for a fee.

To enhance oversight of loan agents, in October 2010, SBA announced it 

would begin requiring lenders to submit reports on fees paid to loan 

agents and other agents who assist borrowers during the loan origination 

process. SBA requires preferred lenders to submit a form, called the Fee 

Disclosure Form and Compensation Agreement (Form 159), which SBA 

officials said can be used to document information about participants in 

the loan origination process, including whether a borrower used a loan 

agent, and if so, the loan agent’s name, company, and compensation. 

SBA Is Taking Steps to 

Enhance Oversight of Loan 

Agents
Page 17 GAO-13-759 Small Business Administration

Lenders submit Form 159 to SBA’s fiscal and transfer agent (FTA), who 

has been recording loan agent information on behalf of SBA since 

December 2010.28

Further, in March 2011, SBA published a notice with guidance to lenders 

on how to submit the form to the agency’s FTA, and the notice highlighted 

SBA’s efforts to create a database that would include all information on 

the form.29

Officials also described other efforts under consideration to enhance 

oversight of loan agents, such as a licensing or certification program. 

Such a system, agency officials said, would allow SBA to assign unique 

identifiers to loan agents. Officials also highlighted discussions with the 

Conference of State Bank Supervisors, which took place in October 2012, 

regarding the use of the Nationwide Mortgage Licensing System and 

Registry (NMLS) or a similar platform for improving SBA’s tracking of loan 

agents.

SBA’s FTA maintains the database that includes information 

from the form. In addition, during our review, officials said SBA is 

adapting the form to obtain more-complete information about the role and 

activities of individuals who assist potential borrowers during the loan 

origination process, including loan agents. SBA plans to update the form 

in fiscal year 2014. Officials further stated that SBA has taken, and is 

considering, other steps to enhance oversight of loan agents. For 

example, SBA has added a provision in its standard operating procedures 

that allows the agency to fully deny liability in the event that the lender 

makes a loan on the basis of a loan package prepared by a debarred loan 

agent. In addition, the agency publishes a list of debarred individuals 

including loan agents on its website.

30

 28Small Business Administration, Loan Agent Data Submission for 7(a) Loans, Information 

Notice Number 5000-1177. 

An SBA attorney advisor noted, however, that legal issues could 

preclude the effective use of NMLS for SBA’s purposes without additional 

legislation, and that this option is still under discussion. According to SBA 

officials, oversight of loan agents is primarily the responsibility of the 

29Small Business Administration, Submission of Form 159 for 7(a) Loans, Information 

Notice Number 5000-1200. 

30The NMLS is a record for nondepository, financial services licensing or registration for 

participating state agencies. This is the sole system of licensure for mortgage companies 

for 54 state agencies and the sole system of licensure for Mortgage Loan Originators for 

58 state and territorial agencies.
Page 18 GAO-13-759 Small Business Administration

preferred lenders, since they have delegated authority over the loan 

origination process.

During the course of our review, we identified discrepancies in SBA’s 

franchise loan data that highlight incomplete or inaccurate data in certain 

fields SBA uses for risk-based oversight of its loans portfolio, which SBA 

has initiated efforts to address. Using data from SBA’s Loan Accounting 

System (LAS), in our review of the 88 loan files for four lenders of the 

franchise organization with the highest loan volume and default rates, we 

found discrepancies between the loan files and LAS. These discrepancies 

generally represent two facets of data reliability—completeness and 

accuracy. For example, we found differences with respect to dates of 

defaults, default status, and whether the franchise was a start-up or 

existing business. Table 1 provides an overview of the discrepancies we 

identified.

Table 1: Summary of Discrepancies Found in the Small Business Administration’s (SBA) Franchise Loan Data

Data reliability 

characteristic Discrepancy

Completeness • We identified four loans during our review of loan files for the four lenders with high default rates 

and loans that were not in the data provided from SBA’s Loan Accounting System (LAS).a

• During our interviews with franchisees, we identified three loans that were not in the LAS data or in 

the loan files provided by SBA.

• SBA did not identify loans that involved the loan agent who was the subject of the allegation for 

three of the four lenders in our review. We identified eight loans through loan file review that 

indicated the participation of the agent or her employer. These loans included one early defaulted 

loan, four defaulted loans, and three nondefaulted loans.b

Accuracy • We identified one defaulted loan, on the basis of information in the loan files from the four lenders, 

that was not marked as such in SBA’s data.

• We found eight loans where the date of default in the loan files was different from the date recorded 

in SBA’s data, three of which were different by at least 3 months.c

• We identified three franchisees that were recorded as “existing” businesses in SBA data, yet the 

loan files showed these were start-up franchisees.

• The loan data provided from LAS included one loan for a franchisee that was an entirely different 

franchise organization than the one we reviewed. 

Source: GAO review and analysis of SBA’s loan data and loan files.

Notes: Data are from SBA’s loan data and loan files for the select franchise organization.

a

For some fields in LAS, SBA relies on lenders to ensure the completeness and accuracy of its data. 

According to SBA, the lender either did not flag these loans as franchise loans or did not include the 

franchise name when submitting the loan.

b

The eight loans we identified were made to eight distinct franchisees. One of the defaulted loans 

involving the loan agent had been identified by the lender as an early defaulted loan in its request for 

an SBA guarantee payment, indicating it had defaulted within 18 months of final disbursement. 

Officials said SBA reviewed this loan and determined it was not an early default, since it had 

defaulted after 18 months from final disbursement. In addition, officials noted the lender that 

SBA Has Initiated Efforts 

to Enhance Reliability of 

Some Franchise Loan Data
Page 19 GAO-13-759 Small Business Administration

originated this loan did not accept the revenue projections in the loan application at face value, since 

the lender lowered the borrower’s revenue projections by 20 percent when determining repayment 

ability. At the time of our work, SBA had not yet completed its review of the other early defaulted loan 

we found among the eight loans.

c

SBA used the date of default to create a field showing whether the franchisees had defaulted, early 

defaulted, or nondefaulted loans. SBA created the field for purposes of our review and using

estimates, since it is not available in LAS. Given the discrepancies we found in the data for default 

dates, we asked SBA to reassess the number of early defaulted loans for all lenders to franchisees of 

the franchise organization, and requested that SBA take into consideration the change in the early 

default definition. In response to our request, SBA identified four potential early defaulted loans made 

by lenders to franchisees of the franchise organization, which were not previously identified because 

SBA did not initially take into account the change in the definition or early defaults. Upon further 

review of the loan transcripts, SBA officials determined that three of the four loans were not early 

defaulted loans.

SBA officials said the agency takes steps to ensure the reliability of its 

loan data and has initiated efforts intended to improve the completeness 

and accuracy of some fields in LAS related to its franchise loan portfolio 

in general. Preferred lenders enter select data into LAS, and they certify 

that the information they enter into the system is accurate and complete, 

officials said.31 In addition, officials noted SBA assesses the accuracy of 

certain data fields when the lender submits a monthly loan status report 

or loan files to request a guarantee payment, and an external auditor 

reviews a sample of loans in LAS to validate that the financial data for the 

loans are accurate.32

 31Preferred lenders are responsible for inputting some fields into LAS such as the 

franchise organization code, which is the unique identifier, as well as the organization’s 

name, borrower’s name, the gross approval amount of the loan, and whether the borrower 

sought financing for starting a new business or acquiring an existing one. In the case of 

the franchise organization we reviewed, if the lender did not input the franchise code or 

name correctly, SBA would not be able to identify the loan in its database. Other fields in 

LAS are generated by SBA or the system itself, including the guaranty percentage, the 

requested guarantee payment, and date of the request.

Officials also said SBA is working with a third-party 

vendor to improve the consistency of franchise information in its database 

by replacing SBA’s current franchise codes with publicly available 

identifiers used in the franchise industry, and to verify the accuracy of 

franchise information in LAS that lenders previously entered. As of July 

2013, officials said the franchise identifiers were ready for use, and the 

agency planned to notify lenders about them. In addition, in August 2013, 

officials said they estimate the franchise identifiers will be introduced at 

the beginning of fiscal year 2014. SBA officials noted efforts to improve 

historical franchise data would be contingent on funding. Because SBA’s 

32Lenders submit a monthly status report of SBA-guaranteed loans to SBA using the 

Guaranty Loan Status and Remittance Form, Form 1502. The form includes information 

about the loan, such as loan status, amount disbursed, guarantee portion amounts, and 

fees. 
Page 20 GAO-13-759 Small Business Administration

franchise data-improvement efforts are in the early stages, it is too soon 

to assess whether SBA’s actions will address the issues with data 

reliability we identified.

We provided a draft of this report to SBA for its review and comment. 

SBA provided technical comments, which were incorporated, as 

appropriate. We also provided relevant sections of a draft of this report to 

the four lenders who made loans to franchisees of the franchise 

organization. We received technical comments from three of the lenders 

and incorporated them, as appropriate, and one lender did not provide 

comments.

In their comments, one of the lenders asked to be dropped from the 

report because of what it described as a relatively fewer number of loans 

and defaults compared to the other lenders. However, we included 

information on the SBA-guaranteed loans made by this lender to 

franchisees to provide more context and perspective on loans to 

franchisees. While relatively smaller based on the number of made and 

defaulted loans to franchisees than other lenders, it met our criteria of 

lenders with the highest number of loans and defaults. The only other 

lender with a comparable number of loans had one defaulted loan.

In addition, we provided a draft of this report to the franchise organization 

for its review and comment. The representatives of the franchise 

organization provided comments on a draft of this report, which we have 

reprinted in appendix IV. In their comments, representatives of the 

franchise organization stated that our comparison of average revenues in 

the FDD and our first-year average revenue calculations is potentially 

misleading and inaccurate because the two sets of data being compared 

are not analogous. Specifically, representatives of the franchise 

organization stated that we are comparing two different sets of data and 

that we point out a significant difference in revenue without explaining the 

differences in such figures. The representatives requested that we more 

clearly state the differences between revenue information contained in the 

FDD and our calculations, which we did. 

However, we disagree with the representatives’ comments that our 

comparison is potentially misleading and inaccurate. The report 

comments on the use of the FDD for projecting first-year revenue, not on 

the accuracy of the average revenue reported in the franchise 

organization’s FDDs. Specifically, the report states that the average 

revenue in the FDD accounted for all franchisees in operation the full 

Agency and ThirdParty Comments and 

Our Evaluation
Page 21 GAO-13-759 Small Business Administration

calendar year before issuance of the FDD. However, we added additional 

language to clarify that our calculation is of first-year average revenue

obtained from reviewing additional revenue data we obtained from the 

franchise organization. Our comparison highlights the difficulties of using 

the FDD as a basis for projecting first-year revenues, since the revenue 

reported in the franchise organization’s FDD is derived from businesses 

in operation at least the full calendar year prior to issuance of the FDD. 

As noted in our report, while franchise organizations can choose to 

include earnings statements in the FDD, federal regulations do not 

require them to provide first-year average revenues for start-up 

businesses in the disclosure document.33

In addition, as noted in the report, our calculation of average revenues 

including existing businesses did not vary substantially from the franchise 

organization’s figures. Representatives of the franchise organization 

requested that we state more clearly in the text of the report that we did 

not identify a substantial difference between our average revenue 

calculations and the franchise organization average revenue in the FDD 

when including existing businesses. We modified our report to more 

clearly state this information. However, by excluding existing businesses 

in our calculation, to the extent possible, we highlighted how average 

revenues disclosed in the franchise organization’s FDDs tended to be 

higher than first-year average revenues, which we believe is material to 

our discussion about the importance of franchisees’ conducting due 

diligence when applying for a 7(a) loan. The franchise organization 

agreed that potential franchisees must be careful in using information in 

However, franchisees are 

required to include first-year revenue estimates in SBA loan applications, 

and this information is not necessarily available to potential franchisees in 

the FDD; thus, they may have to conduct additional due diligence to 

identify this information from other sources, if available. As noted in our 

report, several franchisees told us that they use FDDs when developing 

revenue estimates, and we found that the reported average revenue in 

the franchise organization’s FDD tended to be higher than our first-year 

average revenue calculations. The purpose of our analysis was not to 

assess the accuracy of the franchise organization’s reported revenues in 

the FDD, as the representatives suggest in their comments, but to 

demonstrate how the FDD figures were, on average, higher than our firstyear average revenue calculations. 

 3316 C.F.R. § 436.5.
 

Page 22 GAO-13-759 Small Business Administration

the FDD for estimating first-year revenue. In addition, the representatives 

of the franchise organization noted additional provisions in the FDD that 

address how a prospective franchisee can gather further information. We 

modified the report to include language to address this issue. 

As agreed with your offices, unless you publicly announce the contents of 

this report earlier, we plan no further distribution until 30 days from the 

report date. At that time, we will send copies to the acting Administrator of 

the Small Business Administration, the appropriate congressional 

committees, and other interested parties. In addition, the report is 

available at no charge on the GAO website at http://www.gao.gov. 

If you or your staff members have any questions concerning this report, 

please contact Stephen M. Lord at (202) 512-6722 or lords@gao.gov or 

Wayne A. McElrath at (202) 512-6722 or mcelrathw@gao.gov. Contact 

points for our Offices of Congressional Relations and Public Affairs may 

be found on the last page of this report. GAO staff who made major 

contributions to this report are listed in appendix V.

Stephen M. Lord

Director

Forensic Audits and Investigative Service

Wayne A. McElrath

Director

Forensic Audits and Investigative Service
Appendix I: Objectives, Scope, and 

Methodology

Page 23 GAO-13-759 Small Business Administration

This report describes (1) the magnitude of Small Business Administration 

(SBA)-guaranteed loans to franchisees of the franchise organization, and 

(2) the results of our investigation into the allegation, and aspects of 

SBA’s oversight of its 7(a) loan program with respect to loans made to 

franchisees of the franchise organization.

To conduct our audit work, we examined data for all SBA-guaranteed 

loans to franchisees of the select franchise organization approved from 

January 1, 2000, to December 31, 2011, in order to assess loan volume,

default rates, and the amount of SBA’s guarantee payments made for 170 

loans to franchisees of the franchise organization from 54 lenders. We 

selected this date range in order to obtain a broad understanding of SBAguaranteed loans to the franchisees during different economic conditions 

and from multiple lenders. The original dataset we received from SBA 

included 184 loans to franchisees; however, 16 of these indicated that the 

lender canceled the guarantee on the loan and 2 were outside the scope 

of our review.

1 We therefore excluded these loans from our analysis of 

SBA’s loan data for the franchise organization. From these data, we 

selected four lenders with the highest loan volume and default rates. 

Three of these four lenders are preferred lenders that have delegated 

authority to make lending decisions on behalf of SBA.2

 1

We identified two SBA-guaranteed loans that fell outside the scope of our review, 

including one loan approved for a different franchise organization and another loan that 

was not originated by one of the four lenders. The number of loans we received in the 

original dataset that were relevant to our review, excluding these two loans and the 16 

canceled loans, was 166 loans. However, during our review of the loans from the four 

lenders to the franchise organization, we identified four loans that were not in the dataset 

we received from SBA. Thus, in all, we reviewed 170 loans from the four lenders to the 

franchise organization. 

We also reviewed 

88 SBA loan packages for these four lenders in order to assess 

characteristics of individual loans, such as the extent to which the 

franchisees’ projected first-year revenues differed from actual first-year 

revenues, and to assess the accuracy of certain data fields in the SBA 

franchise loan data. These loan packages included all loan packages for 

these lenders during this time period. We obtained copies of SBA’s riskbased review reports for the four lenders. We also searched the website 

PACER.gov to determine if any of the franchisees that received 1 of the 

2

Prior to March 2011, the four lenders had delegated authority.

Appendix I: Objectives, Scope, and 

Methodology
Appendix I: Objectives, Scope, and 

Methodology

Page 24 GAO-13-759 Small Business Administration

88 SBA loans filed for bankruptcy.3

Moreover, we analyzed revenue data that we obtained from the franchise 

organization to calculate actual first-year revenues of franchisees, when 

possible. We compared these calculations with the projected first-year 

revenues in SBA loan applications for 19 franchisees who used the loan 

agent, or her employer, who was the subject of the allegation. We also 

used the franchise organization’s revenue data to calculate average firstyear revenues for a broader population of franchisees, and compared it to 

average revenues reported in the franchise organization’s disclosure 

documents. We noted several data limitations with the franchise 

organization’s revenue data. The scope of our review included 

businesses with a full 12 months of revenue data that began from years 

2000 to 2011, since our objective was to calculate an entire year of 

business revenue for businesses that opened during that time period. The 

original revenue data provided by the franchise organization included 746 

businesses. After excluding 59 businesses with fewer than 12 months of 

revenue data and 149 businesses that may have opened prior to January 

2000 (16 businesses affected by both of these issues), the total 

population of businesses in the revenue data was reduced to 554. In 

addition, we identified 115 businesses with revenue data that highlighted 

potential reliability issues, including missing, duplicate, and nonsequential 

revenue data. For purposes of data reliability, we excluded these 

businesses from our calculations, and conducted analysis on the 

remaining 439 businesses. To the extent possible, we calculated an 

average revenue figure that reflected first-year revenue of start-up 

We obtained franchise loan 

information from the four lenders when available. To assess the reliability 

of the SBA franchise loan data for the franchisees of the franchise 

organization, we (1) interviewed agency officials knowledgeable about the 

data, (2) performed electronic testing for completeness and accuracy on 

select data fields, and (3) traced fields in SBA’s loan database to primary 

source files when possible. We found discrepancies between data in 

SBA’s loan database and information in the loan files we reviewed. We 

discussed reasons for the differences between the data sources, as well 

as the agency’s processes and policies for managing the quality of 

franchise loan data, with SBA officials. After discussions with SBA, we 

determined the SBA loan data were sufficiently reliable for reviewing 

loans to the franchise organization.

 3

Public Access to Court Electronic Records (PACER) is an electronic public access 

service that provides case information from federal appellate, district, and bankruptcy 

courts. 
Appendix I: Objectives, Scope, and 

Methodology

Page 25 GAO-13-759 Small Business Administration

franchisees. Accordingly, for part of our analysis, we excluded 63 

businesses from the revenue dataset that the franchise organization 

identified as existing businesses, for a total population of 376 businesses. 

The franchise organization was not able to confirm that it identified all 

existing businesses, so our average revenue calculations may include 

both start-up franchisees and existing franchisees. Nonetheless, we 

believe the average revenue figures we calculated provide a reasonable 

basis of comparison to projected revenues for select start-up franchisees, 

as well the franchise organization’s disclosure documents. We discussed 

this methodology with representatives of the franchise organization, who 

confirmed our approach was reasonable. To further assess the reliability 

of the revenue data, we interviewed representatives of the franchise 

organization and performed electronic testing on the data provided. We 

determined that the franchise organization’s revenue data were 

sufficiently reliable for the purposes of this report.

We also interviewed SBA officials about their activities related to 

oversight of the four lenders, efforts to track and monitor loan agents, and 

the assistance provided to potential franchisees during the loan 

application process. In addition, we examined SBA’s policies and 

procedures for overseeing lenders in the 7(a) program. We also reviewed 

reports by SBA’s Office of Inspector General (OIG) and other related 

documents.4

To conduct our investigative work, we reviewed an allegation that a loan 

agent intentionally exaggerated first-year revenue projections on SBA 

loan applications in order to ensure that franchisees would qualify for SBA 

7(a) loans. We interviewed the owner of the franchise organization, the 

loan agent who was the subject of the allegation, her employer, eight 

former franchisees that were referred to us during the course of the 

investigation, and a bank officer that reviewed loans related to the 

allegation. To better understand the franchisees’ experience with the 7(a) 

loan program, we interviewed 14 additional franchisees of the select 

 4

Small Business Administration, Office of Inspector General, The SBA’s Portfolio Risk 

Management Program Can Be Strengthened, Report No. 13-17 (July 2, 2013); Report on 

the Most Serious Management and Performance Challenges Facing the Small Business 

Administration in Fiscal Year 2013, Report No. 13-02 (Oct. 15, 2012); Addressing 

Performance Problems of High-Risk Lenders Remains a Challenge for the Small Business 

Administration, Report No. 12-20R (Sept. 28, 2012); Report No.11-16 (July 13, 2011); and 

Material Deficiencies Identified in Early-Defaulted and Early-Problem Recovery Act Loans,

Report No. ROM 10-19 (Sept. 24, 2010).
Appendix I: Objectives, Scope, and 

Methodology

Page 26 GAO-13-759 Small Business Administration

franchise organization who received 19 SBA-guaranteed loans from one 

of the four lenders with the highest loan volume and default rates. These 

franchisees were selected on the basis of a range of factors, including 

whether they used a loan agent, geographic dispersion, and performance 

status of the loan. We also interviewed three additional loan agents. In 

addition, on the basis of the 88 loan packages we reviewed for the four 

lenders, we identified 24 franchisees that used the loan agent connected 

to the allegation, or her employer, 19 of whom had data available to 

compare the first-year revenue projections on their SBA loan applications 

with the franchisees’ actual first-year revenue. We cannot generalize our 

findings from these interviews to other franchisees, loan agents, franchise 

organizations, or borrowers in the 7(a) program. Our intent was not to 

identify potential fraud or abuse for all franchise loans of the franchise 

organization or the 7(a) loan program as a whole.

We conducted this performance audit from March 2012 to September 

2013, in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence that provides a reasonable basis 

for our findings and conclusions based on our audit objectives. We 

believe that the evidence obtained provides a reasonable basis for our 

findings and conclusions based on our audit objectives. We conducted 

our related investigative work in accordance with the standards 

prescribed by the Council of the Inspectors General on Integrity and 

Efficiency.
Appendix II: Summary of Risk-Based Reviews 

of Four Lenders

Page 27 GAO-13-759 Small Business Administration

As part of its oversight efforts, the Small Business Administration (SBA) 

generally conducts reviews of all 7(a) lenders with SBA-guaranteed loan 

portfolios of $10 million or more on a 12- to 24-month cycle. SBA can 

conduct additional reviews of the lenders if it identifies specific 

performance concerns. Officials highlighted additional factors that could 

determine whether a lender is subject to a risk-based review, including 

the lenders’ risk ratings, industry concentration, and the results of 

previous reviews. SBA conducted risk-based reviews of the four lenders 

we selected for further review. Table 2 summarizes the risk-based 

reviews we received from SBA for the four lenders.

Table 2: Summary of Small Business Administration’s (SBA) Risk-Based Reviews of Four Lenders

Lender SBA review

Lender A SBA conducted five risk-based reviews from 2003 through 2011. In four reviews, SBA assessed Lender A’s 

management of its SBA loan program as acceptable or acceptable with corrective actions required. In one review, 

which was the only one conducted after an SBA Office of Inspector General (OIG) report on this lender, SBA 

determined the lender’s SBA loan program was marginally acceptable with corrective actions required. From 2000 

through 2012, Lender A’s delegated authority had not been suspended or removed. Lender A is currently a preferred 

lender.

Lender B SBA conducted five risk-based reviews from 2004 through 2010. Five reviews determined the lender’s SBA loan 

program was acceptable with corrective actions required. From 2000 through 2012, Lender B’s delegated authority 

had not been suspended or removed. However, Lender B no longer has preferred lending status.

Lender C SBA conducted four risk-based reviews from 2003 through 2010. In the 2003 and 2006 reviews, SBA assessed the 

lender as acceptable. For the last two reviews, SBA determined the lender’s SBA loan program was acceptable with 

corrective actions required. From 2000 through 2012, Lender C’s delegated authority had not been suspended or 

removed. Lender C is currently a preferred lender.

Lender D SBA conducted three risk-based reviews from 2007 through 2011. The three reviews determined the lender’s SBA 

loan program was acceptable with corrective actions required. From 2000 through 2012, Lender D’s delegated 

authority had not been suspended or removed. Lender D is currently a preferred lender.

Source: GAO analysis of SBA’s data.

Note: Data are from SBA’s risk-based reviews and SBA information.

SBA has the authority to suspend, revoke, or deny renewal of or issue a 

shortened period for delegated authority of preferred lenders. According 

to officials, SBA suspended or revoked the delegated authority for two 

preferred lenders in the 7(a) program from 2000 through 2012. Rather 

than suspending or revoking delegated authority, officials said SBA is 

more likely to deny a renewal of delegated authority or grant a shortened

renewal period, since the renewal period can be from 6 months to 2 

years. From fiscal year 2009 through 2012, SBA denied delegated 

authority to 367 lenders. In addition, approximately 1,058 lenders 

received at least one shortened renewal of 6 to 12 months. SBA can also 

place lenders on a “watch list,” which is one of SBA’s monitoring tools to 

Appendix II: Summary of Risk-Based 

Reviews of Four Lenders
Appendix II: Summary of Risk-Based Reviews 

of Four Lenders

Page 28 GAO-13-759 Small Business Administration

identify high-risk lenders that warrant elevated oversight attention. 

Officials told us that high-risk lenders on the watch list include institutions 

that have received a review assessment of less than acceptable with 

corrective actions required and marginally acceptable with corrective 

actions required.

According to SBA, it is developing a new lender oversight framework to 

conduct risk-based reviews. This new framework of risk-based reviews is 

intended to measure the level of risk of each lender participating in the 

7(a) program. As part of this effort, SBA officials said that they plan to 

conduct a pilot project to review 20 to 30 lenders, which is to include 

evaluations of issues related to loan agents and franchisees. As of 

August 2013, SBA had completed 18 pilot reviews. In addition, SBA 

officials said the agency will conduct various types of risk-based reviews 

based on issues unique to a particular lender.
Appendix III: Financial Disclosure Document 

(FDD) Analysis and Franchising Due Diligence

Page 29 GAO-13-759 Small Business Administration

The franchise organization we reviewed included average revenue in the 

FDD that accounted for all franchisees, including both start-up and 

existing franchisees in operation the full calendar year before issuance of 

the FDDs. We obtained and analyzed the franchise organization’s 

revenue data to calculate first-year average revenues, to the extent 

possible, and compared them to average revenues reported in the 

franchise organization’s FDDs.1 We found the average revenues reported 

in the franchise organization’s FDDs from 2000 to 2009 were higher than 

our average revenue calculations, with the exception of 1 year. 

Specifically, for the 10-year period of FDDs we reviewed, the average 

revenue in the franchise organization’s FDD had a median value that was 

1.43 times our average revenue calculation.2

As discussed, current federal regulations stipulate that franchise 

organizations have discretion in what they report in the section of the 

FDD that is devoted to earnings statements, provided there is a 

reasonable basis and written substantiation for the information. All of the 

FDDs we reviewed for the franchise organization cautioned potential 

franchisees that they may not achieve the average revenue reported in 

the FDD and that many factors influence the revenue of the franchise. 

These FDDs also note that the potential franchisees accept the risk of not 

The average revenue in the 

FDD for 1 of the 10 years was lower than our average calculation (our 

average revenue calculation was 90 percent of the FDD for that year). 

However, for the other 9 years, the FDD was at least 1.35 times and at 

most 1.74 times the average revenue figures we calculated.

 1

The average revenue calculations excluded 63 businesses the franchise organization 

was able to identify as an existing business. In addition, the average revenue calculations 

excluded franchisees that had potential reliability data issues, including franchisees with 

data that skipped months and had duplicate values. We also excluded franchisees that did 

not have a full 12 months of revenue data. We did not assess the franchise organization’s 

methodology for calculating the revenue figures in the FDD or the reliability of the revenue 

information. See app. I for additional information on our use of the franchise organization’s 

revenue data. 

2

We also calculated the average revenue figure for the franchise organization including 

both start-up and the 63 existing franchisees. We did not identify a substantial difference 

between our average revenue calculations and the franchise organization’s average 

revenue in the FDD when including the existing businesses. The median value for the 10-

year period of FDDs was 1.42, indicating that the average revenue in the FDD was 1.42 

times our average revenue calculation when we included both start-up and existing 

franchisees. Over the 10-year period, the average revenue in the franchise organization’s 

FDD was at least 1.07 times and no more than 1.58 times our average revenue 

calculation that included both start-up and 63 existing franchisees.

Appendix III: Financial Disclosure Document 

(FDD) Analysis and Franchising Due 

Diligence
Appendix III: Financial Disclosure Document 

(FDD) Analysis and Franchising Due Diligence

Page 30 GAO-13-759 Small Business Administration

achieving the stated average revenue, and that the franchise organization 

has not audited nor in any other manner substantiated the truthfulness, 

accuracy, or completeness of any information supplied by its franchisees.
Appendix IV: Comments from Representatives 

of the Franchise Organization

Page 31 GAO-13-759 Small Business Administration

Appendix IV: Comments from 

Representatives of the Franchise 

Organization

Note: Footnote numbers 

in the draft report may 

differ from those in this 

report.
Appendix IV: Comments from Representatives 

of the Franchise Organization

Page 32 GAO-13-759 Small Business Administration
Appendix IV: Comments from Representatives 

of the Franchise Organization

Page 33 GAO-13-759 Small Business Administration
Appendix IV: Comments from Representatives 

of the Franchise Organization

Page 34 GAO-13-759 Small Business Administration
Appendix V: GAO Contacts and Staff 

Acknowledgments

Page 35 GAO-13-759 Small Business Administration

Stephen M. Lord, (202) 512-6722 or lords@gao.gov

Wayne A. McElrath, (202) 512-6722 or mcelrathw@gao.gov

In addition to the contacts named above, Heather Dunahoo, Assistant 

Director; Rick Hillman; Maria McMullen; Linda Miller; Gloria Proa; Gavin 

Ugale; Elizabeth Wood; and Heneng Yu made key contributions to this 

report.

Appendix V: GAO Contacts and Staff 

Acknowledgments 

GAO Contacts 

Staff 

Acknowledgments 

(192405)
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